A closer look at R&D tax credits for ship and boat building

The marine industry is no stranger to innovation and uncertainty. Boat building projects, including government vessels; commercial ships; and recreational boats can frequently qualify for R&D tax credits, but it’s important that the qualified activities and expenses are correctly identified and properly documented to support the credit.

In addition to shipyards and boat builders, certain third-party consultants such as naval architects can also potentially qualify for the credit.

What is the R&D tax credit?

The R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no limitation on the amount of expenses and credit that can be claimed each year. If the R&D credit can’t be used immediately or completely, any unused credit can be carried forward for up to 20 years.

In addition, previously filed tax returns can typically be amended for up to three years to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes.

Here are some of the most common client questions we encounter on this topic.

How much can a company save with R&D tax credits?

With a wide variety of qualified expenses within the boat building industry, it’s difficult to give an exact estimate. Depending on company size and the types of activities performed, our clients have saved anywhere from $50,000 to $5 million through R&D tax credits.

The high costs required to design and build first-in-class vessels or prototype hulls can often lead to substantial credits.

The amount saved is based on the amount of expenses that are determined to be eligible for the credit, not the revenue generated by a company. Generally, we find the amount of federal credits to be approximately 5%–10% of a company’s development expenses during a given year, and this can be much higher when state credits are factored in.

Note that qualified development expenses generally include much more than just internal research and development (IRAD). Expenses incurred under contract also often qualify if certain criteria are met.

What does the R&D credit apply to?

Companies that take on technically challenging projects that require the design and development of new or improved hulls, onboard systems and components, or new construction techniques generally have expenses eligible for the credit.

Additionally, technical uncertainty often exists due to the high complexity of onboard systems and challenging integration of those systems.

Here are some examples of boat and ship building activities that may qualify:

• Design of new hulls or improving existing hulls, including custom builds
• Development of new or improved construction techniques such as resins, glass fabrics, layup processes, or joining and welding techniques
• Design of new or improved internal systems such as propulsion or electrical systems
• Design of more efficient manufacturing processes

What’s the next step to apply for these credits?

The first step is to have an analysis performed on the types of projects your company is working on to identify eligible activities. The key is to find someone who not only understands the marine industry, but also the rules surrounding the R&D tax credit, to help you identify qualified activities and quantify eligible expenses.

The ship-building industry has an especially complicated legal history with determining qualified expenses in relation to how both hull design and subsystems can impact a vessel as a whole, so it’s important for your advisor to have a deep knowledge of how to navigate the process.

For example, specific case law exists that covers integration risks involving third-party subsystems incorporated into new vessels.

It’s also important to consider the extensive risk and uncertainty involved with designing and building new vessels. Some first-in-class ships prove to be unseaworthy after being commissioned.

Identifying and collecting documentation that supports the credit is an important factor when trying to make a claim. These can include designs, test reports, evaluations, and communications that detail the analysis that took place to overcome challenges and develop solutions to successfully complete the project.

While companies are often tempted to calculate credits on their own, there’s a considerable amount of knowledge required to identify and collect the correct information. Claiming credits incorrectly can result in the loss of credit and possible state and IRS penalties.